Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Wednesday, 30 April 2014

I’m a
Krugman fan. Unfortunately he makes mistakes in this article which is
critical of Martin Wolf’s recent article on
full reserve banking.

First,
Krugman criticises Wolf for concentrating on retail banks, while ignoring the
fact that the crisis was largely a run on shadow banks. Well it’s inconceivable
that Wolf is unaware of the latter shadow bank point. Presumably Wolf ignored
shadow banks for the sake of brevity.

Next
Krugman gives us “three thoughts”, the first one of which is actually closely
related to the latter shadow bank point. Krugman says “If we impose 100%
reserve requirements on depository institutions, but stop there, we’ll just
drive even more finance into shadow banking, and make the system even riskier.”

Well
(revelation of the century this) I think we’ve all now tumbled to the fact that
it’s daft to impose various regulations on conventional banks while omitting to
impose the same regulations on shadow banks, particularly given the huge
expansion in shadow banking over the last decade.

As Adair
Turner (former head of the UK’s Financial Services Authority) put it and in
reference to shadow banks: "If it looks like a bank and quacks like a
bank, it has got to be subject to bank-like safe-guards."

Krugman’s
second thought.

Krugman’s
second “thought” is that “Cochrane’s proposal calls for a remarkable amount of
government intervention in finance…” Excuse me? The Dodd-Frank regulations
currently stand at about 10,000 pages and according to some have actually made
things worse, not better. In contrast, I set out the basics of full reserve
banking here in about
300 words.

In short,
if it’s near useless regulations of Byzantine complexity you want, don’t bother
looking at the rules that govern full reserve banking. Look at EXISTING
attempts to prop up FRACTIONAL RESERVE banking.

Krugman’s
next criticism of John Cochrane is to querie the idea that “we can easily set
things up so that the manager of your index fund sells a tiny piece of your
stock portfolio every time you use a debit card”. That point will not be clear
to the uninitiated, so I’ll explain.

It would be
possible to have a system where checks can be drawn or debit cards “drawn” on
an account which contained not money, but investments of the sort that a
typical mutual fund makes. Thus it might seem that some of those investments
would need to be sold every time someone uses their debit card.

However, selling
two shares in General Motors when someone buys their weekly groceries with
their debit card would clearly be absurd. I.e. it would be better to keep a
stock of base money and only sell a decent sized bundle of investments when the
latter stock was too low.

But in any
case, most of those who back full reserve do not advocate the above “sell one share
at a time” or even a “sell a bundle of shares” system. That is, they advocate a
system (much like the existing system) where it’s up to bank customers or
depositors to make sure there is enough in their safe / current accounts to
fund check or debit card transactions.

However,
Cochrane’s “sell a bundle” system would be perfectly feasible, and the question
as to which system to implement could perfectly well be left to individual
banks. (See “Incidental Note” below for more on this point, if you want).

Krugman’s
third thought.

His 3rd
thought is that banking was not the only thing wrong around 2008. I.e. there
were other problems: he cites over-indebted households. Well hang on: why were
those households over indebted? It was caused in part by irresponsible banks
using every trick in the book to get people to take out loans they couldn’t
afford! I.e. the problem was BANKS.

And even if
there were factors that contributed to the crisis which had nothing to do with
banks, the fact remains that banks had an awful lot to do with it.

Incidental Note.

There is
actually some logic in the existing practice adopted by most banks, that is
requiring depositors THEMSELVES to make sure there is enough in their current or
checking accounts. And under full reserve, the same logic would apply. The
logic is thus.

If a bank
itself is responsible for shifting money from a term or investment account to a
safe / checking / current account, then there is no effective difference
between the two accounts.

Moreover,
under the existing system, banks definitely want to know how much of their
depositors’ money those depositors might spend in the next month or so: when
banks know that, they know they are free to lend on a proportion of that money.
So to that end, banks want to see a POSITIVE COMMITMENT from customers to not
spend sundry sums of money in the next month or so. And when depositors
THEMSELVES shift money from current / checking accounts to term accounts, that
certainly represents a commitment of a sort.

And much
the same point would apply under full reserve. Thus my guess is that banks
would not be keen on Cochrane’s “sell a few shares every ten minutes” system.

Tuesday, 29 April 2014

I’m always interested in
arguments against full reserve. So far all I’ve found is a selection of badly
flawed arguments, and this paper by
Douglas Diamond and Philip Dybvig is typical. It’s entitled “Banking Theory,
Deposit Insurance, and Bank Regulation”. D&D’s criticisms of full reserve
appear in their section III, and their argument (which clearly indicates they
haven’t studied the subject) starts as follows. (D&D’s actual words are in
green below).

“One proposal is to impose a 100% reserve requirement, that is, a requirement
that intermediaries offering demand deposits can hold only liquid government
claims or securities, for example, Treasury bills or Federal Reserve Bank
deposits (which might pay interest). This proposal specifically restricts banks
from entering the transformation business (they cannot hold illiquid assets to
transform into liquid assets), and therefore the proposal precludes banks from
performing their distinguishing function. If successful, this policy would
remove the purely monetary causes of bank runs by limiting banks to performing
liability services. The net effect of such a policy is to divide the banking
industry into two parts. The regulated part of the industry would still be
called banks but would be effectively limited to providing liability side
services. The other part of the industry would be an unregulated industry of
creative firms exploiting demand for the transformation services previously
provided by banks but that banks could no longer supply under 100% reserves.”

Answer to the above passage.

The
above passage is a joke. It certainly does not set out 100% reserve banking as
proposed by 100% banking’s main advocates (e.g. Irving Fisher or Milton
Friedman) in the years prior to D&D’s paper (1986). The above passage is
simply D&D’s own bizarre idea as to what 100% reserve banking consists of.

To
illustrate, Irving Fisher in his book “100% Money and the Public Debt” (1936)
says “..each commercial bank would be split into two departments, one a
warehouse for money, the checking department, and the other the money lending
department…”. I.e. far from lending being done by what D&D call
“unregulated creative firms”, lending entities are very much regulated under
full reserve.

And
Milton Friedman, another advocate of full reserve, describes full reserve in
his book “A Program for Monetary Stability” much as Fisher does. Specifically
Friedman says “The effect of this proposal would be to require our present
commercial banks to divide themselves into two separate institutions. One would
be a pure depositary institution, a literal warehouse for money…….The other
institution that would be formed would be an investment trust or brokerage
firm. It would acquire capital by selling shares or debentures and would use
the capital to make loans or acquire investments.”

Neither
Fisher nor Friedman say anything about one half of the banking industry being “unregulated”,
as claimed by D&D.

D&D continue.

“Even if banks would still be viable without the rents to providing the
transformation service, the proposal would just pass along the instability
problem to their successors in the intermediary business. The instability problem arises
from the financing of illiquid assets
with short-term fixed claims (which need not be monetary or demand deposits).”

The answer to that is that
obviously if “illiquid assets” are funded from “short-term fixed claims” then
the relevant entity is fragile: or in D&D’s words the “instability problem”
is “passed along”. Indeed, the latter defective form of funding would make the
whole switch to full reserve near pointless. That’s why the advocates of full
reserve (Friedman, Fisher, Lawrence Kotlikoff, etc) SPECIFICALLY advocate that
funding is done by SHAREHOLDERS and NOT BY “SHORT-TERM FIXED CLAIMS”. Doh!

Mutual Funds.

Then in the rest of that
paragraph of D&D’s, they make the point that the deposit taking half of the
former banking industry is similar to money market mutual funds, and they
complain about the fact that no transformation or “creation of liquidity” takes
place as a result.

Well the answer to that is
that stopping private banks creating liquidity or if you like creating money is
a SPECIFIC OBJECTIVE of full reserve banking: it’s not a flaw which has remained
hidden till those two geniuses Diamond and Dibvig revealed it. As Fisher put
it, “We could leave the banks free, or at any rate far freer than they are now,
to lend money as they please, provided we no longer allowed them to manufacture
the money which they lend.”

Next, D&D ask:

"If banks adopted this
structure, who would hold the illiquid assets (loans) currently held by banks?"

Well if D&D had bothered
reading the Chicago plan and/or Fisher and/or Friedman, they’d know the answer,
which is of course that those “illiquid assets” are held by the lending
entities or lending departments of banks that arise when full reserve is
implemented.

Commercial Paper.

Next (para starting
“Commercial banks…”) D&D point out that corporations use commercial paper
to raise cash in a hurry, and that this process would be more difficult under
full reserve.

Well the
answer to that is that short term loans to corporations are only one of many
types of loan in modern economies. E.g. there are very small scale high
interest loans made by back street loan sharks, and long term and relatively
low interest rate loans granted to mortgagors, to name just two. And contrary
to D&D’s claims, there is nothing very special about large short term loans
to corporations: that is, a number of GENERAL POINTS can be made about lending
given a switch to full reserve and which are applicable to all types of
lending, not just lending backed by commercial paper. Those points are as
follows.

First, full
reserve obviously restricts lending, but given the excessive and irresponsible
lending that caused the crunch, it’s not immediately obvious why that’s a
problem. As to the demand reducing effect of that restriction, that can be made
up for by creating and spending base money into the economy, which in turn
results in firms and households having a bigger stock of money. Thus any
interest rate rise caused by implementing full reserve would tend to be
counterbalanced by a reduced need for households and firms to take on debt.

The net result
is that those corporations which D&D are so worried about (and indeed all
other debtors or potential debtors) would tend to keep a larger stock of money
to tide them over periods when their stock of money tended to be low, rather
than resort to money lenders. And give current record levels of private debt,
that’s probably a desirable outcome.

Money
lenders cannot be controlled?

In their
penultimate sentence, D&D make the following claim which they don’t even
try to substantiate: “Furthermore, the proposal is likely to be ineffective in
increasing stability since it will be impossible to control the institutions
that will enter in the vacuum left when banks can no longer create liquidity.”

Well the first
flaw in that argument is that under full reserve, as explained above,
“liquidity” or money is created by the central bank, not private banks. Thus
it’s debatable as to whether there is any sort of “vacuum” to which D&D
refer.

However,
printing money and lending it out, which is what private banks do, is a potentially
profitable business. So doubtless numerous shadow banks would try to get into
the money or liquidity creation business.

However, one
answer to that was given by Adair Turner (former
head of the UK’s Financial Services Authority) put it and in reference to shadow banks
which prior to the crunch were scarcely regulated at all: "If it looks
like a bank and quacks like a bank, it has got to be subject to bank-like
safe-guards."

But clearly
imposing those “bank-like safe-guards” will never be done with 100% efficiency:
that is, numerous smaller shadow banks will try to evade the rules. But
actually there isn't a huge problem there, and for the following reasons.

The tax
authorities normally manage to trip up naughty self-employed people with a turnover
of £50k or £100k a year who are not declaring their earnings to the tax
authorities. And £100k a year is a
RIDICULOUSLY SMALL turnover for a shadow bank. Thus the authorities ought to be
able to uncover the existence of any shadow bank with a turnover of say more
than £1m a year, and if they can do that, that cracks the problem.

Can small
entities create money?

Moreover, it
is debatable as to how much money creation small shadow banks, particularly
small ones can do. My Penguin dictionary of economics starts its definition of
money with the sentence “Anything which is generally acceptable as a means of
settling debt.” Now the liabilities of well-known and large High Street banks
are “generally acceptable” for the purposes of buying a car or purchasing your
groceries. E.g. cheques drawn on Barclays or Lloyds are widely accepted, and
credit cards with “Barclays” or “Lloyds” or “Visa” printed on them are generally
accepted. But you’d probably be wasting your time with a cheque drawn on some
unheard of shadow bank.

Maturity
transformation.

Moreover, size
pays when it comes to maturity transformation. To illustrate, if a bank is
funded by ten thousand depositors, the bank can calculate very accurately the
proportion of those depositors likely to withdraw their money in a particular
week or month.

In contrast,
if a bank is funded by just TEN depositors or other type of short term
creditor, it would be well advised not to do any transformation at all.

So to summarise,
failing to keep tabs on the smaller shadow banks would be a minor problem for
full reserve.

Monday, 28 April 2014

A common
criticism of full reserve banking is that it equals monetarism or Milton
Friedman’s version of monetarism: that’s the idea that controlling the amount
of money is the best way of controlling aggregate demand. E.g. see paragraph
starting “This is very close…” here.

Apart from
Friedman himself, I’ve never come across an advocate of full reserve who
advocates monetarism. Certainly I don’t. Thus presumably most of them agree
with the more conventional view, namely that while the quantity of money (base
money in particular) does have an effect, the ACTUAL PROCESS of expanding that
stock also has an effect, where that is done by simply creating new base money
and spending it into the economy rather than done via QE. Moreover in his
1948 paper, "A monetary and fiscal framework for economic stability" (American Economic Review) he advocates full reserve, he does not put any emphasis on the
monetary rather than fiscal effects of creating new monetary base and spending
it into the economy (or cutting taxes). But looks like he changed his mind on
that later in his career. (BTW that paper is normally available for free online, but it's vanished today.)

Incidentally,
I said “rather than done via QE” above because QE has little effect on the
stock of private sector net financial asserts, while in contrast, a “print and
spend” policy DOES INCREASE that stock.

To illustrate
the above “monetary / fiscal point” if the central bank / government machine
creates and spends enough to employ an extra thousand government employees by
this time next month, and those extra employees are actually hired, then
employment rises by one thousand, all else equal. Revelation of the century
that, wasn’t it?

But note, that
when those extra employees start work, the money supply won’t have risen: that
is, the employment increasing effect comes from what might be called the fiscal
element in “print and spend”.

Of course
the latter point assumes that the economy has spare capacity, i.e. that the
effect of the extra money will not simply be to boost inflation. Plus I’m
ignoring the multiplier to keep things simple, plus I’m assuming no Ricardian
effects. But as Joseph Stiglitz said “Ricardian equivalence is taught in every
graduate school in the country. It is also sheer nonsense.” So my “no
Ricardianism” assumption probably doesn’t fly in the face of the facts too
much.

Sunday, 27 April 2014

Since
Wolf’s article
in the Financial Times a few days ago, his article has attracted plenty of
criticism. These criticisms are easily dealt with, especially since the critics
don’t seem to have studied the BASICS of full reserve. So here is:

1. A quick explanation
of the basics.

2. A guide
the explanations set out by the main advocates of full reserve (Milton
Friedman, Lawrence Kotlikoff, James Tobin, Richard Werner, Hyman Minsky, etc).

The
basics.

Under full
reserve, the banking industry is split in two. One half simply accepts deposits
and lodges the money at the central bank (or – the option preferred by Milton
Friedman – invests the money in short term government debt). That money is
instant access, but pays little or no interest. Those deposits are backed by
the state, but since there is virtually no risk, the cost to the taxpayer of
backing those deposits is near zero. I.e. there is almost no subsidy of the
banking industry there, plus that half of the industry cannot fail and cause
credit crunches.

Or as
Minsky put it, "..one
such subsidiary can be a narrow bank which has transaction balances as
liabilities and government debt as its assets. This narrow bank does not need
deposit insurance.."

Loans
and investments.

The second
half of the industry performs the lending and investing functions performed by
conventional banks, but that half is funded by shareholders or loss absorbers
who are effectively shareholders. In Laurence Kotlikoff’s version of full
reserve, the second half consists of mutual funds, and of course those with a
stake in mutual funds are effectively shareholders. The exception there is
money market mutual funds: obviously they belong to first half of the industry.

And that
second half of the industry cannot fail either, although there is nothing to
stop one of the relevant entities declining slowly. That is, if an entity makes
silly loans, it doesn’t suddenly become insolvent: all that happens is that the
value of its shares (or mutual fund units) fall in value. So no bank subsidies
are needed there either.

So to
summarise so far, we have, 1, disposed of the need for taxpayers to underwrite
bank deposits, 2, disposed of other bank subsides, and 3, disposed of the
possibility of sudden bank failures, and hence the severity of credit crunches,
and all in a couple of hundred words. Not bad, given the complete failure of
Dodd-Frank, Vickers
etc to do anything remotely similar despite spending millions on the problem
and exuding tens of millions of words on the problem.

Deflationary
effects.

Obviously, the
introduction of full reserve restricts lending and that reduces aggregate
demand. But that’s easily dealt with by standard stimulatory measures. The
actual stimulatory measure preferred by Friedman and Positive Money is simply
creating and spending base money into the economy (which comes to the same
thing as fiscal stimulus followed by QE).

The net
result of that is that private debts decline and the typical household and firm
has a bigger stock of money. And given the sharp rise in private debts over the
last decade that’s probably desirable. Or to use Positive Money (PM) parlance “debt
encumbered money” shrinks, and “debt free money” expands.

As to who
decides the amount of stimulus, that is done under the PM / Werner system by a
committee of economists. And that’s not much different to the existing system:
e.g. the Bank of England Monetary Policy Committee decides on interest rates
and thus has a big say on stimulus.

Plus, as
under the existing system, that sort of committee DOES NOT have a say on strictly
political matters, e.g., 1, the proportion of GDP allocated to public spending,
or 2, whether stimulus comes in the form of increased public spending or tax
cuts, or 3, how any increased spending is split as between different government departments. I.e. under
the existing system the Bank of England MPC adjusts interest rates and leaves
it to politicians to adjust public spending if they so wish. While under the PM
/ Werner system, the committee decides how much extra (or less) base money is
to be created and spent, while leaving to it politicians to decide EXACTLY HOW
that money is spent (or whether the money is used to cut taxes).

Guide to
literature by Friedman, Kotlikoff, Tobin, etc.

For
Friedman see his book “A Program for Monetary Stability” (published by Fordham
University Press), Ch3 under the heading “Banking Reform”. Here is an extract:

“The effect
of this proposal would be to require our present commercial banks to divide
themselves into two separate institutions. One would be a pure depositary
institution, a literal warehouse for money. It would accept deposits payable on
demand or transferable by check. For every dollar of deposit liabilities, it
would be required to have a dollar of high-powered money among its assets in
the form, say, either of Federal Reserve notes or Federal Reserve deposits.
This institution would have no funds, except the capital of its proprietors,
which it could lend on the market. An increase in deposits would not provide it
with funds to lend since it would be required to increase its assets in the
form of high-powered money dollar for dollar. The other institution that would
be formed would be an investment trust or brokerage firm. It would acquire
capital by selling shares or debentures and would use the capital to make loans
or acquire investments.”

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

.

Bits and bobs.

.

As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

.

MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A